Investment for prosperity

Investment

Egypt’s current economic situation can be summed up in the stories of three young men from different backgrounds. The three lost their jobs over the past few months in incidents that show how the country is in dire need of further investment and capital flows.

Waleed, 30, holds a diploma in agriculture and used to work in a factory in 10 Ramadan City until a budgetary crisis hit, leading to salary cuts, layoffs and ultimately to the factory closing. Waleed is now jobless and is forced to live on loans from relatives. His son has also dropped out of school because he can no longer afford public schooling.

Mohamed, a 27-year-old engineer, may be luckier than Waleed, but only in the sense that he does not have a family to support. Mohamed used to work in a real-estate company which also closed due to economic problems that have resulted in Mohamed remaining jobless and having to rely on his father for his expenses.

Mahmoud, 35, similarly lost his job in a foreign company that had to close its branch in Egypt after financial problems. Mahmoud had to move his children from private to public schools and is now working as a driver for the Uber and Careem car services to make ends meet.

Unemployment rates in Egypt dropped slightly from 12.3 per cent in the second quarter of the last fiscal year to 12 per cent in the third quarter, as shown in figures from the Central Agency for Public Mobilisation and Statistics (CAPMAS). But there are still too many stories of young men and others losing their jobs due to problems facing local and foreign investment, and these are likely to push up the curse of unemployment rates again.

The latest figures indicate that the average cost of a job opportunity, previously some LE 200,000 per year, has now doubled due to recent economic problems.

The country’s economic adversity really began following the 25 January Revolution in 2011, and it had soared to critical levels by the beginning of last year when the foreign currency reserves were drying up, dropping to an average of $15 billion that would hardly cover the nation’s needs for imports for more than three months ahead.

The major crunch in Egypt’s foreign reserves was the result of a slump in tourism as well as a drop in remittances from expatriates, stagnant Suez Canal revenues, expensive petroleum and non-petroleum imports and shrinking foreign direct investment.

Tourism was a major source of income before the revolution, as official figures indicated that it contributed 20 per cent of Egypt’s foreign reserves, which reached $36 billion before the revolution, and 6.5 per cent of local economic activity. Whereas petroleum and non-petroleum exports used to cover about 50 per cent of Egypt’s foreign reserves, tourism also used to cover about 50 per cent of the trade budget deficit before the revolution.

Tourism picked up temporarily in 2014 before it slumped again in October 2015 after the crash of a Russian plane over Sinai, reaching its worst levels in years. Expatriate bank transfers dropped after a temporary rise following the revolution, and Suez Canal revenues declined in the wake of a global economic recession and a slowdown in global trade flows. There was also the expense of channelling LE60 billion into expanding the Suez Canal by digging a new waterway connected to the original one.

Gulf support for Egypt’s economy also severely declined from $20 billion following the 30 June Revolution in 2013 that ended the rule of Muslim Brotherhood president Mohamed Morsi to less than $1 billion in the aftermath of the falling oil prices that have hit the economies of the Gulf.

In a bid to save what is left of Egypt’s foreign reserves, the Central Bank of Egypt (CBE) placed restrictions on transferring foreign currency abroad and reduced the amount of dollars available for clients, pushing clients to head to the black market where the dollar exchange rate was much higher than the official one.

The dollar shortage and the high exchange rate reflected on the country’s ability to attract foreign investment. In the meantime, many local factories stumbled financially, and some had to close in the light of the dollar crunch and their inability to import raw materials at the high exchange rate while having to pay tariffs at the official rate and leading to major losses.

Efforts to revive Egypt’s sluggish tourism sector have hit difficulties because some countries have maintained their rigid stance on flights to Egypt, especially Russia, a major source of tourists to Egypt in recent years. These countries have claimed that Egypt is unable to provide sufficient safety measures in airports, among them the UK which has insisted on suspending flights to Sharm El-Sheikh.

Egypt’s ability to borrow money on the international markets has weakened because of low credit ratings, and the government has had to depend on domestic borrowing at interest exceeding 15 per cent.

INVESTMENT THE SOLUTION: In the light of these adversities, bolstering investment would be the best option.

Direct foreign investment used to contribute nine per cent of the country’s foreign reserves in 2010, but the revolution in 2011 scared investors away and capital flows dried up causing Egypt to lose $21 billion in local and foreign investments, according to official figures.

Prior to the revolution, Egypt saw some $6 billion in direct foreign investment, and happily that figure has now returned, with the country’s direct foreign investment figures jumping to $6 billion once again in the first months of the fiscal year that ended in June. CI Capital Research, a leading Egyptian research house and EFG Hermes, a leading investment bank, speculate that direct foreign investment could jump to $8 billion by the end of the current fiscal year that started in July.

“But these are still small numbers that do not match the size of the Egyptian economy,” Ahmed Shams, head of research at Hermes, told Al-Ahram Weekly. “They do not account for more than two per cent of local production, which reached LE3 trillion in the last fiscal year.”

The government has started an economic reform programme in the hope of attracting foreign investment and bolstering the confidence of the international markets in the Egyptian economy. The programme was part of government plans to secure a $12 billion loan from the International Monetary Fund (IMF), which was tied to a set of economic reform measures. These started with amendments to the tax system, imposing a 13 per cent Value Added Tax (VAT) in fiscal year 2016-17, rising to 14 per cent in the current fiscal year as an alternative to the former 10 per cent sales tax.

The government also issued a new civil service law aimed at reducing an overblown public sector overstaffed with some seven million employees, one of the highest figures in the world.

Last, but not least was the CBE’s decision to let the Egyptian pound float freely last November in the hope of attracting further foreign investment. The floating of the pound was not an aim in itself, but was a means to eliminate trading of the hard currency on the black market and ending the dollar shortage. In the months following the floatation the CBE relaxed its restrictions on the exchange of hard currency. In Mid June is scrapped all caps on bank transfers abroad.

Commensurate with the floatation, the CBE hiked its key interest rates by three per cent on deposit and lending rates to reach 14.75 per cent and 15.75 per cent, respectively. The large hikes intended to encourage Egyptians to hold onto their pounds, provoked wide criticism among local investors, who complained the moves were likely to further sap investment and curtail their ability to obtain the finances needed to protect their companies against bankruptcy.

The CBE, however, did not respond to such complaints and even decided to hike interest rates in May and again last week in response to advice from the IMF. The latter visited Cairo earlier this year in order to monitor Egypt’s commitment to its economic reform programme after it had received the first instalment of the loan of $2.275 billion.

In its latest increase of interest rates the CBE hiked its overnight deposit rate, overnight lending rate by two per cent to 18.75 and 19.75 per cent. The move was meant as a way to counter inflation, which had reached 30-year highs of around 30 per cent.

The IMF had said that lowering inflation was key to keeping the economic reform programme on track and that raising key interest rates could be an appropriate tool for doing so, according to Reuters. Critics, however, argue that the nation’s large bank deposits have nothing to do with inflation, which they say is mainly caused by recent economic measures including the floatation of the pound, leading to a halving of its exchange value, as well as tax hikes and subsidy cuts that have imposed further burdens on most of the population.

Countries often increase interest rates when liquidity is outstripping the supply of commodities on the market, bringing the situation towards equilibrium. However, for many experts this has not been the case in Egypt, and although many local investors agree that the floatation of the pound was a necessary step to curb the dollar black market and that the gradual lifting of energy subsidy was also a step in the right direction, the consensus remains that local investment is likely to shrink in the coming period.

For many observers, however, the recent economic measures have started to yield results, as can be seen in the growth of foreign investor appetite for Egypt’s domestic debt. According to the ministry of finance, foreign investment rose to $9.8 billion as of 1 July, compared with $1.1 billion the previous year.

In the meantime, Egypt’s two tranches of Eurobond offerings, the last of which was a $3 billion issue in May, have seen significant interest from foreign investors and yielded revenues that have boosted the country’s international reserves, lifting them to $31.1 billion in the same month.

ECONOMIC FEARS: The influx of foreign investors into the Egyptian market through the purchase of domestic treasury bills and bonds has been hailed by officials as a sign of increased trust in the Egyptian economy.

But the issue remains bogged down in doubts on the part of local investors and economists who fear dependence on such indirect investment. Hani Tawfik, chair of the board of directors of the Union Capital Company for Direct Investment and a capital market expert, is among those ringing alarm bells against such investment, especially in the form of short-term debt, which he insists is “hot money that enters and leaves quickly without actually attaining the wanted goals”.

“Interest rates are almost at zero elsewhere in the world, and so it is only logical that increasing interest rates on treasury bills in Egypt would lure foreign investors,” Tawfik told the press recently.

Interest rates on Egypt’s treasury bills increased to almost 20 per cent, while interest rates on Eurobond offerings in the international markets have not been less than 6.5 per cent, depending on the bonds’ maturity. Most developed countries, with the US topping the list, have been adapting expansionary economic policies since the world economic crisis in 2008. Those policies have included reducing interest rates to near zero. While the US has hiked interest rates twice since the end of last year, these have still not reached one per cent.

Direct investment means pumping money into new projects or expanding existing ones, guaranteeing that the money stays fixed for a long period of time and hopefully also bringing in technology, providing employment and increasing imports and exports, all ultimately contributing to the growth of the economy and development. This is not the case with indirect investment in financial instruments, however.

Mohamed Abu Basha, an analyst with EFG Hermes, speculates that direct investment will soon pick up in Egypt thanks to the new investment law passed by the parliament and ultimately ratified by the president recently. He told the Weekly that “a law that defines the responsibilities of each party is the key to encouraging investment,” adding that there would even be a spike in non-petroleum investments.

“Petroleum investments used to represent up to one-third of all direct investments in Egypt, but this is bound to change in this new fiscal year,” Abu Basha said.

The parliament recently passed a long-awaited investment law to streamline doing business in Egypt by pledging to reduce bureaucracy and create enticing tax incentives that it is hoped will lure foreign investors back to the country.

The new law includes a raft of new incentives, such as a 50 per cent tax discount on investments made in underdeveloped areas, government support for the cost of connecting utilities to new projects, and restoring private-sector free zones. One provision of the law pledges to pay back investors half of what they pay to acquire land for industrial projects if production begins within two years.

Instead of long bureaucratic delays in obtaining permits, in the past sometimes requiring the blessing of more than 70 government agencies, a one-stop shop will now manage all the paperwork. Any requests not dealt with within 60 days will be automatically approved.

The law has long been bogged in discussion among different ministries, especially regarding terms concerning allocating land for investors and forfeiting tax revenues in tax-free zones in times of austerity. The law was ultimately signed by President Abdel-Fattah Al-Sisi early June, and the draft executive regulations were submitted to the cabinet for approval just before the Eid break.

Many businessmen who spoke to the Weekly said they would wait until the law was applied before judging the outcome, arguing that while the law was good in itself, its application would define whether it succeeded in luring investment.

“The problem was not inadequate legislation, but the application of laws on the ground,” Mubasher International Market Research noted in a document issued following the passage of the law.

Ziad Bahaaeddin, a former deputy prime minister and former chair of the General Authority for Investment and Free Zones, similarly noted that “we currently need to focus on the real obstacles facing investors which are entrenched in the environment that both local and foreign investments have to deal with.”

According to Bahaaeddin, those obstacles include what he termed “the obscurity, or double-standards, of state economic policies that encourage private investments on the one hand and expand the economic role of the state on the other, involving the state’s civil and military sectors in ordinary business areas that do not have strategic significance.”

Bahaaeddin also said that “prolonged legal disputes concerning those with frozen assets or on travel ban lists, or who have been arrested in financial corruption cases, must be legally settled to prove them either guilty or innocent, in order that the judiciary does not lose its credibility and there is trust in its ability to apply the laws independently.”

Egypt does not only need to attract investment, as the type of that investment also matters if it is to boost economic growth. This was the message conveyed by a recent study by Cairo University professor of economics, Reem Abdel-Halim, who insisted on the importance of channelling direct foreign investment to labour-intensive fields that should also match the demographic characteristics of the areas they are set up in.

The focus should be on projects that depend more on labour than technology, such as the food, chemical and wood industries, she said.

The new law includes terms that should help put Abdel-Halim’s suggestions into effect, including granting tax incentives to labour-intensive projects and offering free land for investments in Upper Egypt where poverty rates are the highest nationwide. The law also offers tax cuts for companies setting up in underdeveloped areas or special sectors, though none of this means that the application of the new law will be plain sailing.